Chinese Economy Finally Slowing; What It Means for Its Stocks

By George Leong, B.Comm. Published : June 3, 2013

Chinese stocks continue to be major underperformers this year—they have been for the past three years from 2010 to 2012. I must admit that having been a bullish supporter of Chinese stocks, it has been a major disappointment; but like everything in life, things will surely get better. I’m just not putting a timeframe on when Chinese stocks will regain their glory and outperform.

At this juncture, there is no evidence that the landscape for Chinese stocks will improve soon. The Shanghai Composite Index (SCI) is up a mere 2.12% this year, easily underperforming the S&P 500 and the Dow. Even the Nikkei 225 has blown away the SCI.

Just take a look at the comparison in the chart below of the SCI (as indicated by the red candlesticks) and the S&P 500 (as indicated by the green line). The purple oval on the right side of the chart shows the divergence forming between the SCI and the S&P 500 since around 2008, based on my technical analysis.

Chart courtesy of www.StockCharts.com

In the short- to medium-term of less than one year, the SCI will likely continue to underperform the U.S. key stock indices.

For Chinese stocks to come back, two things must happen:

First, China must make sure the Chinese economy doesn’t falter back into a tailspin. The new government, under President Xi Jinping and Premier Li Keqiang, must work to drive domestic consumption in the country to levels similar to those in the United States and Japan, where consumer spending accounts for about two-thirds of the countries’ gross domestic product (GDP). In China, domestic consumer spending currently only accounts for about 25%, so there’s plenty of work ahead.

To increase local spending, Chinese wages must rise. We are seeing this now, but it must continue in both the cities and the rural areas of China. A wealthier China means less dependence on exports and on what happens in the global economy.

China is estimated to show growth that will still far overshadow that of Japan and many parts of the global economy. According to the Organization for Economic Cooperation and Development (OECD), in its semi-annual Economic Outlook report, the agency reported that China is estimated to expand its economy by 7.8% this year, followed by 8.4% in 2014. (Source: “Global economy advancing but pace of recovery varies, says OECD Economic Outlook,” Organization for Economic Cooperation and Development web site, May 29, 2013.)

China is clearly stalling, as evidenced by key companies in the country. In its first-quarter report, Chinese infrastructure company Joy Global Inc. (NYSE/JOY) stated that “China’s economy has not been able to get traction and continued slowing has reduced the demand for coal. Electricity demand is growing at only half the rate of prior years, reflecting a significant deceleration in the economy.” (Source: Alva, M., “Coal Glut, Weak Demand Hit Mining Company Joy Global,” Investor’s Business Daily, May 30, 2013.)

I don’t think China will tank, but the country will continue to struggle to get back on track; albeit, it’s unlikely the country will ever be the way it used to be.